30. Estimated or total return?
Before talking about returns, it is always worth remembering the maxim of every investor: past returns do not guarantee future returns. The opposite, that is, thinking that because an investment has behaved very well so far, it will continue to do so in the future, leads to one of the basic mistakes when investing: chasing performance.
This mistake is typical and occurs every day in equity investing. As Nobel laureate Daniel Kahneman explains, “investors are prone to overconfidence, and (…) Overconfidence causes us to misinterpret information and let our emotions cloud our judgment.” This overconfidence causes many investors to choose hot funds – which have performed above average – in the belief that they will remain highly profitable in the future. The reality, however, is that, in general, spectacular profits on the stock market are followed by spectacular falls. Consequently, investors who pursue past performance enter the market at a high price and get very poor, or even negative, returns.
The principle that past performance does not guarantee future returns does not prevent us from talking about future returns, although we must do so with caution. After all, when we invest we all want to have an idea of what will happen to our money in the future. That’s when the estimated profitability comes into play. To explain what we mean, we will give the example of Urbanitae.
Estimated profitability in Urbanitae
Since May 2022, the supervisor of real estate crowdfunding platforms does not allow estimated profitability figures to be advanced in capital gains projects. That’s not to say you can’t estimate the profitability of a project. This calculation is in no way based on profitability from previous projects, but on the business assumptions of the particular project.
In capital gains projects, Urbanitae carries out an exhaustive study of this business plan presented by the developer and adjusts it downwards – and contrasts it with a third party, such as, for example, Tecnitasa. The result of this adjustment is the forecasts of income and expenses that Urbanitae publishes in the project file, and which serve as the basis for calculating the estimated profitability. That is, the profitability that under normal circumstances the investor can expect.
In the case of debt projects, the profitability responds to the conditions of the loan agreed between Urbanitae and the developer, specifically the interest and the term set for its repayment. In this case, it is allowed to publish the estimated profitability figure, for two reasons. The first is that the conditions are fixed in advance; the second, to achieve The estimated profitability in a debt project does not depend so much on the future – on how the specific project goes – as on the repayment capacity of the promoter –that is, whether it has the means to repay the loan to investors today–.
Total profitability in Urbanitae
The estimated profitability can be total or annual. The total is also known as final profitability or cash-on-cash . When we adjust that total profitability to the term, usually to one year, we are talking about the internal rate of return or IRR, as we explained when we talk about returns in Urbanitae. When the project is not finished, we will talk about estimated CoC or IRR. When it is returned, we can already talk about real CoC and IRR.
An important aspect to remember is that the returns published by Urbanitae are gross returns. The benefits you obtain for your investments with Urbanitae are taxed as savings income, in tranches that start at 19%. In general, at the time of returning the project, it will make the minimum withholding established by law, precisely 19% of the dividends obtained.
To finish with the example, nothing better than contrasting the estimate with reality. In the case of Urbanitae, things have gone quite well to date. The platform has returned 22 projects entirely to its investors: on average the annualized return (IRR) reaches 17%, compared to an estimate of 13.5%. The total return, on average, is 20.2%, compared to the forecast of 19.4%.
If we separate the projects from capital gains, which aspire by nature to higher returns, the figures are even more positive. In equity projects, the final IRR of the nine projects returned to 100% was 19.9%, compared to an estimated IRR of 15.3 %. In debt, the average final IRR was 14.9%, compared to a forecast of 12.2%.
Not bad numbers, are they? But, you know, before investing, take your time: check the forecasts, ask questions, visit our section of Learn with Matías, call us. And, if you are convinced by what you see, invest.